FLP administration issues.

• Author: Satchit, Vinu
• Position: Family limited partnerships

In cases such as Est. of Dorothy Morganson Schauerhamer, (1) Est. of Charles E. Reichardt, (2) Est. of Morton B. Harper (3) and Est. of Albert Strangi, (4) the Tax Court agreed with the Service's argument that assets transferred to a family limited partnership (5) (FLP) were includible in the transferor's estate under Sec. 2036.

In general, under Sec. 2036, the entire value of a transfer is includible in a transferor's gross estate when the transferor has retained (1) explicitly or implicitly, a right to possession or enjoyment of the property or the income therefrom (Sec. 2036(a)(1)); or (2) the right to designate the persons who shall possess or enjoy the property, or the income therefrom (Sec. 2036(a)(2)). The statute does not apply to transfers that are bona fide sales for adequate and full consideration in money or money's worth (bona fide sale exception).

Whether a transferor has implicitly retained an economic benefit under Sec. 2036(a)(1) is a question of fact; the courts typically look at "all of the facts and circumstances surrounding the transfer and the subsequent use of property" in making such determination. (6)

Many crucial factors relate to a FLP's formation stage, others to yearly FLP administration. The requirement to prepare an annual income tax return provides the CPA with an opportunity to detect yearly administration problems that may inadvertently imply an understanding to retain economic benefit. The checklist in Exhibit 1 on p. 353 and the appendix on p. 355 will assist a CPA in such process.

Exhibit 1: FLP administration checklist Commingling of assets Yes No Comments 1. Does the FLP have its own bank (or financial institution) accounts? -- -- 2. Is the income from FLP assets deposited -- -- directly in FLP accounts within a reasonable time of receipt of such funds (as opposed to being deposited in a partner or third-party accounts and subsequently transferred to FLP accounts)? -- -- 3. Are income items from FLP assets reported in the FLP's name and employer identification number (e.g., on Forms 1099 and Schedules K-1)? -- -- 4. If the FLP owns shares of a closely held business, are dividends attributable to these shares being paid directly to the FLP (as opposed to being paid to the transferor and subsequently redeposited by him or her into the FLP account)? -- -- 5. If the FLP owns rental properties, are the rent checks being made out to it (and nut the transferor, regardless of whether the transferor reimburses the FLP for the amounts received)? -- -- 6. Are all the deposits being made to FLP accounts related strictly to the FLP's activities (as opposed to personal sums being deposited in FLP accounts, then transferred to a partner or third party)? -- -- 7. Are any personal expenses of the partners being paid directly from the FLP (regardless of whether they are reclassified as distributions or loans at year-end for tax return and/or bookkeeping purposes)? -- -- 8. Are expenses related to FLP assets still being invoiced to the transferor (regardless of who pays such expenses)? -- -- 9. Are FLP assets being used as collateral for any partner's personal or business debts (other than loans of the FLP guaranteed by the partner)? -- -- 10. Have the transferors stopped identifying the contributed assets as their personal assets on personal financial statements, credit applications, insurance applications, etc.? -- -- Distributions 11. If distributions were made during the year, was the decision to make them made by parties authorized by the FLP agreement to make such decisions? -- -- 12. If distributions were...